Drivers of inflation in core goods and services

Inflation in the prices of goods excluding energy has fallen sharply across many economies, while inflation in services excluding shelter remains elevated. Examining the factors behind recent shifts can provide insights into where inflation may be headed, at least over the near term.

Inflation in the prices of goods excluding energy has fallen from its peak of 7.2% in September 2022 to 0.3% in June, which is below its historical average. In contrast, inflation in services prices excluding shelter has moved up recently and is close to its historical average.

Goods excluding energy

Inflation in the prices of goods excluding energy has fallen sharply across many economies. Lower input costs have been a key driver of this decline, including in Canada.1

Input costs picked up strongly over 2021 due to factors such as pandemic-related supply disruptions, weather events and high energy prices. Food inflation picked up soon thereafter. After peaking in mid-2022, these cost pressures began to dissipate, and food inflation has fallen steadily (Chart 18).

Decline has been broad-based

Inflation in goods excluding food and energy has also fallen significantly, declining from its peak of 5.8% in June 2022 to -0.5% in June 2024. This decline has been broad-based. All major categories have seen large decreases in inflation, and most have had outright price reductions from recent highs.

Lower costs have been a major factor. In particular, shipping costs and energy prices declined after rising sharply in 2021 due to pandemic-related supply disruptions. Inflation rates have also declined notably for many imported finished goods, such as clothing, and intermediate goods, such as plastic and chemicals.

Moreover, because consumer spending on many goods excluding food and energy is discretionary in nature, softer domestic demand has also contributed to the decline in inflation. This weakness in discretionary spending is consistent with evidence from the Canadian Survey of Consumer Expectations and the Business Outlook Survey.

Services excluding shelter

Services excluding shelter inflation in Canada was 2.9% in June, close to its historical average. This is lower than the levels observed in the United States and the euro area, which have remained around 4% to 5% (Chart 19).

In Canada, for much of the past year, inflation in services excluding shelter was running around 2%, well below its historical average. This weakness reflected a combination of factors, including the emergence of excess supply and an unusually steep decline in communications prices.

Underlying inflationary pressures remain

However, inflation in prices for services excluding shelter has picked up in recent months as the pace of price declines from communications has eased. In fact, if communications prices were removed from services excluding shelter, inflation for this category would be 3.8% (Chart 19, yellow line). This may suggest that there are more underlying inflationary pressures in this category.

For a closer look at the underlying inflationary pressures in services excluding shelter, Bank of Canada staff calculated a median inflation rate measure for this category based on the prices of around 10,000 individual services.2 This rate is still elevated relative to normal, suggesting underlying inflationary pressures remain (Chart 20).

Microdata from the Labour Force Survey (LFS) also suggest that elevated growth in labour costs may have been putting upward pressure on inflation. The median inflation rate of services excluding shelter and the measure of wage growth based on the microdata are shown in Chart 20.3 There is a clear correlation between the two series.

While this measure of wage growth has been volatile, it has fallen from its peak. This suggests that inflation in services excluding shelter will moderate if wage growth continues to ease.

Endnotes